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The Reykjavk Grapevine Issue 18 2013 12

Economics
s | Overload!

lafur is a Ph.D.
student in econo-
mics at the Uni-
versity of Exeter,
emphasizing FDI
The Great Icelandic Jubilee
and financial
stability. Making sense of the debt relief
lafur Margeirsson

pension savings can be used to pay addi- Iceland isn't great you know. with an interest hike to try to hold credit
tionally onto the principal in the future. Second: OK, if we can tax the old demand back. That will hit the borrow-
The tax-free pension savings can also be banks to get cash for a debt jubilee, ers with non-indexed loans, as their
saved and later used to buy a flat. This is couldn't we have used the money for interest rates are potentially readjusted
why they say that even current tenants something else? Like the Icelandic pub- upwards. (A more effective and sensible
will benefit from the measures. lic radio, which were practically shut- way of limiting credit growth and infla-
ting down? Or using it to pay decent tion would be to impose direct credit
But how are they wages to doctors and nurses? I'm not controls and connect them to the banks'
putting myself up against the debt relief own net holdings of liquidity in foreign
paying for all this? as a principle, just pointing out that we currencies. But I doubt the Central Bank
didn't have to spend all the cash on it. will go down that road: you can't teach
Right, that's a bit hazy. The short answer Or maybe we can tax them even old dogs new tricks.)
on the list of FAQs on the Prime Minis- more and spend that tax income on Third, although the net assets of
ter's Office website is classic nonsense: something nice!? the old bankrupt banks will contract
Q: How is the debt relief financed? (assuming everything goes according
A: The Treasury will collect increased to plan), we will still have "consider-
revenues in the next four years to cover In sum
able" pressure on the balance of pay-
the cost of additional state expenditure
Now, there are some good things about ments because of increased consump-
resulting from these actions. The ac- c tion and demand. Now, of course, part
tions will therefore neither be financed this measure.
First of all, they did it! Jubilee is here, of the reason for those measures is to
by additional Treasury borrowing nor
well done guys! You proved that this is revive household consumption, but if
with the granting of state guarantees. it takes us into even riskier waters with
Right, so the no-bullshit answer of is politically possible and economically
that it doesnt have to be absolute non- the balance of payments than we are
theyre going to increase taxes! in, doesn't that just signal that the ex-
Where are they going to "collect in- sense. Some very indebted households
will feel quite relieved and this will change rate is too strong? And imagine
creased revenues? Specifically, they are
have a positive impact on the economy what will happen if and when the ex-
going to tax the estates of the old banks, change rate goes down: inf lation goes
i.e. the banks that went bankrupt in although the impact may be short lived.
The tax-free pension part of it also up, principal of debt grows back and
2008. Their liquidation process is going we're back to square one.
veeeery slowly, to a large extent due to makes perfect sense and simply boils
down to the fact that it is not a smart to So again: why, oh why did they not
capital controls, which are holding back abolish indexation parallel to those
the process. Yet the estates have to be liq- save with a 23% interest when you owe
debt bearing 45% interest. measures?!
uidated before we can abolish the capital
But I do have to admit that I have con- Fourth, and this is perhaps my most
controls. Its like being a driver with two
cerns, besides the obvious ones like the serious concern. We haven't fixed the
back seat drivers, one demanding you
Sigtryggur Ari taxation issue. institutional drawbacks of the Icelandic
drive faster and the other demanding
First, the primary loan, or the new economy. Besides still having the in-
that you slow down. Which one are you
loan, which the borrower has to pay off, dexation on mortgages, we still have a
going to make unhappy?
The hottest story coming from Iceland now is the one The government is going to make will still be indexed, just like the original high self-imposed rate of interest stem-
loan that is now being partially written ming from the pension system (which
about the government-initiated debt relief to house- the old banks unhappy. Besides outright
off. We will therefore still have all the is required to get a real rate of return
taxing them to pay for a debt jubilee for of 3.5% and it controls assets equal to
holds. Here is my take on it, focused only on a hand- households, they are considering chang- negative effects of indexing mortgages
about 120130% of GDP). What do you
ing laws that would force them to speed in Iceland, including more volatile and
ful of the issues related to the act itself and, perhaps up the liquidation process. higher inflation, higher interest rates, think will happen to the long-term rate
a less effective monetary policy and the of interest with such a gigantic buyer of
more importantly, its potential economic impact. I have two immediate concerns
about this. risk of having to have another debt jubi- financial liabilities that demands a high
lee in 10 years time or so. minimum rate of interest? Has anybody
First, those are two birds in the bush,
Second, and closely related to my heard of monopsony?
but not one in the hand. Are we definite-
The basics So what's the crack? first concern, although there is no di- Although politically this may fuel
ly sure that they can tax the old banks?
rect increment in money supply because some fires, even in other countries
This sentence alone from the Prime
Framsknarf lokkurinn (The Progres- Icelandic households will get 150 bil- of the measures, I believe we can safely where over-indebted populations may be
Ministers slides says it all: "The com- nudged to demand jubilee, I fear that the
sive Party, PP) promised to carry out lion ISK (750 million GBP) of their assume that not only will we have some
mittee [behind the debt jubilee] assumes net effects of this particular debt jubilee
a debt jubilee if elected in the latest household debt "cancelled" over a four- potential demand-pulled inflation im-
that the measures will be fully funded
general elections. They were. And they year period. I say "cancelled" because mediately in the wake of the jubilee, but will not be significant in the long run,
over a period of four years.
formed a coalition government with they are in fact paying down 70 billion also increased credit demand as well (es- at least from an economic point of view.
Great going, guys. I do this all the When it comes to the Icelandic economy,
Sjlfstisf lokkurinn (The Indepen- ISK of it themselves with the tax-free pecially if we have an increase in moral
time, too. I just book my vacation to I fear we will only have short spurts of
dence Party, IP). pension savings. hazard due to all this: will people take on
French Polynesia and assume that I can
As the IP did not agree with the PPs The rest, 80 billion ISK, will be out- more debt because they anticipate an- economic bounce back. It is not enough
finance it! 80 billion ISK!? Pennies mate,
idea of simply cancelling the debt, the right cancelled in four annual instal- other debt jubilee in the future?). to cut the leaves of the weeds, we need to
I'll pick them up off the floor one day!
outcome is a mix of both parties ideas: ments, although the borrower will im- As the increased credit demand will dig out the roots as well.
And even if they can tax the old banks
80 billion ISK (roughly 400 million GBP) mediately feel the positive impact on his be met with new loans that increase the
specifically (there are some concerns An extended version of this piece originally
of household debt will be outright can- or her monthly payment burden. Each money supply, we will end up with fur-
about whether it would be constitution- appeared on lafurs blog: http://icelandi-
celled, and an additional 70 billion ISK household that has an indexed mortgage ther inflation pressures. And because
ally possible or not), won't the old banks,
will become available to people who use specifically declared to buy property for the principal of indexed debts will grow cecon.blogspot.com
which are the main owners of Arion and
their third pillar pension savings in the its own use (buy-to-let mortgages are ex- with more inflation, we will get some, or
slandsbanki banks, not just pass at least
next three years to pay down their house- cluded!) will get a maximum 4 million even all, of the "jubileed" debt back.
part of the cost onto their customers?
hold debts. ISK of the debt written off. Non-indexed The Central Bank will also respond
Competition in the banking industry in
loans get no write-off, but the tax-free